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Overview I Oxford Analytica, “Risk of Secular Stagnation is Rising,” March 7, 2014 As pace of global recovery continues at a slow pace concern that developed economies may enter a period of “secular stagnation. Idea put forward by modern Keynesians, Larry Summers and Paul Krugman Relies on Keynesian intuition that demand is currently insufficient to Match idle capacity Boost economic growth, or Lower unemployment 2

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Overview II Stylized Facts More than five years after the global financial crisis, GDP growth across advanced economies is weak, Unemployment stubbornly high Inflation low, threatening to turn to deflation Rising income inequality and foreign reserve accumulation are Contributing to lower consumption and excess savings at global level Which has dampened the impact of historically low interest rates 3

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Overview III Main propositions of the stagnationists: Unless week demand is addressed, supply side reforms that increase capacity will not boost growth Increased capital requirements by banks will constrain credit, diminishing the impact lower borrowing costs have on investment Addressing income inequality through tax reform would help boost domestic demand The worry is that secular stagnation might result in a structurally lower economic growth potential, condemning advanced economies to years of growth to weak to reduce unemployment 4

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Causes of Secular Stagnation Summers identifies the global savings glut – a chronic shortage of investment relative to savings Main cause of weak demand and slow growth Income inequality Growing disparity between income earners at the top and bottom of the income distribution has an adverse impact on global demand The very rich consume proportionally less of their income than the middle class or poor This drives savings up and global demand down. Foreign reserve accumulation The built up of foreign reserves by countries relying on export led growth rather than domestic demand reduces consumption. This boosts savings and hurts global demand 5

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Solutions to Stagnation I A number of broad policy solutions have been put forth to counter secular stagnation: Real interest rates One solution to boost demand would be to further lower real interest rates (interest rates minus inflation) While interest rates have fallen in recent years, equilibrium interest rate (that is consistent with full employment) has fallen further Implies that in order to stimulate the economy by encouraging borrowing, real rates must fall far below the low – and in some cases negative – rates currently seen Lowering real rates could be achieved by central banks using unconventional monetary policy such as quantitative easing (QE) Another solution: lower real rates by increasing inflation expectations (anticipated inflation) 6

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Solutions to Stagnation II Fiscal Policy Public stimulus measures – similar to those seen in the recession could be effective in ending secular stagnation Public authorities could breathe life into sluggish economies by increasing investment directly Summers preferred method for addressing securer stagnation Not only does public infrastructure investment not require an institutional change, makes sound economic sense given that many governments face negative real rates with borrowing in financial markets. 7

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Solutions to Stagnation III Structural reforms Advocated by the OECD in 2014 Report “Going for Growth. Recommended measures include Lower product market regulation Enhancing competition Reforming pubic education systems and further liberalization of labor markets Such measures would be effective in boosting capacity and raising growth potential in the long run. 8

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Limitations to Solutions I There are serious limitations to the policy responses offered by the Keynesians to counter secular stagnation: Zero-lower bound Central banks lose the ability to stimulate the economy when interest rates are at or near zero. Even quantitate easing (QE) measures in this environment have not been sufficient to boost growth Philosophy is to get investors to move into riskier assets – same problem that caused the 2008 collapse in the first place Bubbles Extremely low interest rates and QE might actually become counter productive Have caused prices of assets to increase rapidly May create bubbles in housing and assets triggering financial stability 9

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Limitations to Solutions II Public Finances In much of developed world there is very little room for maneuver when public debt is close to or higher than 100% GDP Currently the case in the U.S. United Kingdom and France Political Consequences Unlike monetary policy fiscal policy solutions require democratic debate and political conseqnces Might be emerging consensus on fiscal policy at the global level (IMF, G20), but clearly lacking in the US and EU EU rules government public deficits and debt prevent any fiscal stimulus from being implemented Political gridlock between Democrats and Republicans has prevented any public investment strategies since the passing of the 2009 stimulus bill 10

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Limitations to Solutions III Timing Investment in innovation and knowledge that raises the growth potential of the economy is always beneficial, but will do little to foster demand in the short tun Of these limitations the lack of political will and consensus is the most serious as infrastructure investment would likely be the most timely and effective way of addressing secular stagnation Institutional deadlocks prevent this. 11

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Conclusions Summing up Policy solutions to address secular stagnation – and slow growth more generally – appear few and far between The United States and EU are very unlikely to engage in the kind of strategies – particularly pubic investment that might reduce secular stagnation risk U.S. political system is polarized Tax policies to smooth out income distribution and raise purchasing power of lower income groups a non-starter Increased minimum wage a very inefficient way to do this EU is constrained by strict fiscal policy rules Without political consensus advanced economies could risk entering a period of prolonged structurally soft growth. 12